Underwriting is an agreement, entered into by a company with a financial agency, in order to ensure that the public will subscribe for the entire issue of shares or debentures made by the company. The financial agency is known as the underwriter and it agrees to buy that part of the company issues which are not subscribed to by the public in consideration of a specified underwriting commission. The underwriting agreement, among others, must provide for the period during which the agreement is in force, the amount of underwriting obligations, the period within which the underwriter has to subscribe to the issue after being intimated by the issuer, the amount of commission and details of arrangements, if any, made by the underwriter for fulfilling the underwriting obligations.
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The underwriting commission may not exceed 5 percent on shares and 2.5 percent in case of debentures. Underwriting has become very important in recent years with the growth of the corporate sector. It provides several BENEFITS to a company:-
To act as an underwriter, a certificate of registration must be obtained fromSecurities and Exchange Board of India (SEBI). The certificate is granted by SEBI under the Securities and Exchanges Board of India (Underwriters) Regulations, 1993. These regulations deal primarily with issues such as registration, capital adequacy, obligation and responsibilities of the underwriters. Under it, an underwriter is required to enter into a valid agreement with the issuer entity and the said agreement among other things should define the allocation of duties and responsibilities between him and the issuer entity. These regulations have been further amended by theSecurities and Exchange Board of India (Underwriters) (Amendment) Regulations, 2006.
Selection of a good underwriter is of the utmost importance, but it’s important to understand that many underwriters are equally selective of their clients. Because an underwriter’s reputation depends on successful issues, few firms will be willing to stake their reputation on questionable companies.
In addition to SEC registration filings, the underwriter will create a preliminary prospectus that will become a major part of the issue’s marketing campaign. This document is also referred to as the red herring, after a small red passage in the document that states that the company is not attempting to sell shares prior to SEC approval. Once SEC approval is obtained, the underwriter and the corporation will embark on a road show to gauge and attract interest from investors. While the road show does not involve getting binding commitments from investors, it helps the underwriter determine the best strategies for pricing and issuance. After the initial public offering, the underwriter continues to provide services for the newly public corporation. For months or even years after the offering, the underwriter may continue to make a market for the stock, ensuring liquidity for investors and making the shares more desirable. Twenty-five days after the issue, the underwriter is also permitted to make statements or projections regarding the company and its prospects.
When a company wants to raise funds throughinitial public offering (IPO)it appoints aninvestment bank for underwritingthe issue. AnInvestment bankis also called asmerchant bank. There is no regulatory restriction to use the services of amerchant bankfor IPO. Since in an IPO a company participates for the first time, it doesn’t have complete understanding of the rules and documentation, required to be submitted, to get a clearance from the regulator. Famous merchant bankers world over are Goldman Sachs, Credit Suisse and Morgan Stanley. Banks like Deutsche, Citi, UBS etc have investment banking wings. Underwriters assess and analyze firm’s current performance, firm’s future earnings potential, industry scenario, competition in the same sector, current local and global market situations etc. to decidethe issueprice/price band. They also work on the activities like completion of the mandatory documentation as required by the regulatory body. Underwriters charge a fee for this activity, which is generally a percentage ofthe issuesize. If the issue size is very large a syndicate of merchant banks takes up the task of underwritingthe issue. However onemerchant bankleads the other.
They offer a package of financial services. The basic function of merchant banks is marketing corporate and other services that are guaranteeing sales and distribution of securities and also other activities such as management of customer services, portfolio management of customer services, portfolio management, credit syndication, acceptance credit, counseling, insurance, etc. As per SEBI (Merchant bankers) Rules, 1992: “Merchant bankers means any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, advise or rendering corporate advisory service in relation to such issue management.”
Merchant banking activity was formally initiated into the Indian capital markets when grind lays bank received the license from reserve bank in 1967.grindlays started with management of capital issues ,recognized the needs of emerging class of entrepreneurs for diverse financial services ranging from production planning and system design to market research .even it provides management consulting services to meet the requirements of small and medium sector rather than large sector. Citibank setup its merchant banking division in1970.the various tasks performed by this divisions namely assisting new entrepreneur ,evaluating new projects ,raising funds through borrowing and issuing equity. Indians banks started banking services as a part multiple services they offer to their clients from 1972.state bank of India started the merchant banking division in 1972.in the initial years the SBI’S objective was to render corporate advice and assistance to small and medium entrepreneurs.
There are 135 merchant bankers who are registered with sebi now in India. There are public sector, private sector and foreign players registered with sebi. The below are the examples of few of the merchant bankers in each of the public, private and foreign players.
Project counseling includes preparation of project reports,deciding upon the financing pattern to finance the cost of the project and appraising the project report with the financial institutions or banks.it also includes filling up of application forms with relevant information for obtaining funds from financial institutions and obtaining government approval.
This forms the main function of the merchant banker.he assists the companies in raising funds from the market.the main areas of work in this regard include: instrument designing, pricing the issue, registration of the offer document, underwriting support and marketing of the issue, allotment and refund, listing on stock exchanges.
Management of issue involves marketing of corporate securities viz. equity shares, preference shares and debentures or bonds by offering them to public. Merchant banks act as per SEBI guidelines, the merchant banker arranges a meeting with company representatives and advertising agents to finalize arrangements relating to date of opening and closing of issue, registration of prospectus, launching publicity campaign and fixing date of board meeting to approve and sign prospectus and pass the necessary resolutions. Pricing of issues is done by the companies in consultant with the merchant bankers.
The managers of the issue assist in the drafting of prospectus, application forms and completion of formalities under the companies act, appointment of registrar for dealing with share applications and transfer and listing of shares of the company on the stock exchange. Companies can appoint one or more agencies as managers to the issue.
Underwriting is a guarantee given by the underwriter that in the event of under subscription, the amount underwritten would be subscribed by him. Merchant banking subsidiaries cannot underwrite more than 15% of any issue.
Portfolio refers to investment in different kinds of securities such as shares, debentures or bonds issued by different companies and government securities. Portfolio management refers to maintaining proper combinations of securities in a manner that they give maximum return with minimum risk.
AA merger is a combination of two companies into a single company where one survives and other losses its corporate existence. A takeover is the purchase by one company acquiring controlling interest in the share capital of another existing company. Merchant bankers are the middlemen in setting negotiation between the companies. Merchant bankers assist the management of the client company to successfully restructure various activities, which include mergers and acquisitions, management buyouts, joint ventures among others.
The merchant bankers help their clients in the following areas involving foreign currency:
Merchant banker is the intermediary appointed by companies in the primary market issue. It has to look at the entire issue management and work as the manager to the public issue.
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